Mboweni defends inflation policy

South African Reserve Bank (SARB) Governor Tito Mboweni defended the country’s inflation targeting framework on Thursday, vowing that the central bank will continue to make decisions based on international best practice.

In a speech to a Bureau for Economic Research conference in Cape Town, he also said the four interest rate hikes so far this year were appropriate.

”We hold the view that South Africa’s economic prosperity will be enhanced by a price stability approach to monetary policy, and that inflation targeting framework is the most appropriate to achieve this objective.”

Although some economists believed monetary policy based on price stability would compromise economic growth, many governments internationally had recognised that inflation destroyed an economy’s potential.

Mboweni said it was too early to fully assess the second round effects of relatively high wage increases and price rises this year.

They were, however, a cause for concern, and the bank would vigilantly monitor the situation in the months ahead.

”The four measured and timely increases in short-term interest rates so far this year to counter the inflation spiral were entirely appropriate, but inflation expectations have nevertheless continued to harden somewhat,” he said.

The SARB has raised rates by 400 basis points this year to counter rising inflation fuelled by a dramatic fall in the value of the rand last year.

A number of economists are predicting another hike after the SARB’s monetary policy committee meets on November 27 and 28, although an increase in the upper level of the country’s inflation target for 2004 has eased some fears.

Finance Minister Trevor Manuel announced last week the upper limit would rise from five to six percent. The target for this and next year remains at between three and six percent.

The four rate increases this year have also placed inflation targets firmly in the spotlight, with some commentators questioning whether such a framework was right for a developing country such as South Africa.

Mboweni said inflation targeting had significantly strengthened the SARB’s mandate on price stability, and had improved the forward-looking inflation expectations in most sectors of the economy.

”Interestingly, every single country that has adopted an inflation targeting framework has up to the present continued to adhere to it.”

The governor said in view of the relatively long transmission lags between interest rate changes and inflation, it was important that corrective measures were timeous and measured.

”Flexible inflation targeting implies that the bank should avoid severe corrective actions to bring inflation in 2003 or any of the subsequent years to within the target range at significant cost to the real economy.

”At the same time, however, the bank must ensure that any second-round inflationary pressures that would jeopardise the target for 2003 and beyond are contained.”

The recovery in the economy appeared to be sufficiently strong to weather the impact of the interest rate increases.

He added near-term growth prospects were encouraging and official estimates for the first two quarters of the year had exceeded expectations.

But, the economy remained vulnerable to concerns about longer-term growth prospects and high priority should continue to be given to structural reforms to help lower unemployment and raise living standards.

It was important the country built on its increasingly favourable credit ratings, and that it further distinguished itself from ”countries that have discredited themselves in the eyes of the international community,” he said. – Sapa

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